U.S. stocks slumped to close sharply lower today as the Dow Jones Industrial Average sank more than 800 points and the S&P 500 had its worst day since February as technology stocks went into a freefall. Investors were spooked by rising bond yields dumped equities in all sectors, triggering a broad market rout.
The Dow Jones Industrial Average DJIA, -3.15% skidded 831.83 points, or 3.2%, to 25,598.74, logging its worst one-day drop since February. The S&P 500 index lost 94.66 points, or 3.3%, to 2,785.68, falling for its fifth straight day, the longest losing streak since November 2016. The large-cap index’s losses were topped by the technology sector, which slid 4.8%, the steepest percentage drop since August 2011. The Nasdaq Composite Index COMP fell 315.97 points, or 4.1%, to 7,422.05, its biggest decline of 2018.
What drove the market?
Many believe market action has been adversely affected by higher bond yields and interest rates, both of which could signal a new phase in post crisis markets that have enjoyed a protracted period of ultralow yields.
A rise in yields results in steeper borrowing costs for corporations and investors, and has caused a reassessment of equity valuations, already deemed lofty by some measures. On top of that, richer rates of so-called risk-free bonds can attract investors away from equities, which are perceived as comparatively riskier. However, rising yields are also seen as a reflection of a strong economy, one that has been supported by a number of strong economic data points.
Traders were also looking ahead to the start of the third-quarter earnings season, which unofficially begins later this week with results from major financial institutions. Broadly speaking, earnings growth is expected to be strong, which could provide an underpinning to equity prices, although there have been some concerns that expectations are too high, which could lead to disappointments.
In the latest economic data, the producer-price index rose 0.2% in September, while the core PPI was up 0.4%. Separately, wholesale inventories in the U.S. rose 1% in August. Late Tuesday, Dallas Federal Reserve President Rob Kaplan said he sees some inflationary pressures building, but that he doesn’t think there will be a sudden spike in prices. He also said he sees a risk of higher oil prices in coming years.
President Donald Trump on Tuesday had repeated his criticism of Fed policy, saying the central bank doesn’t have “to go as fast” with raising interest rates. The Fed has raised rates three times this year and it has indicated it would do so again in December. We believe the Fed has done a good job with its rate policy the last year or so to try and moderate a hot economy but the President may have a point. With the Fed selling bonds from its previous QE activity during the years after the financial crisis, it is putting more pressure on bond markets (increasing yields), The net effect is higher rates beyond the headline interest rate increases made by the Fed. We believe the Fed will slow the amount in which they raise rates in 2019 until they have sold off more of their balance sheet.
The other big news effecting the markets is our trade policies. President Trump embarked on a mission to renegotiate our unfair trade agreements with the current strong economy at his back. His ambitious plan is working and he has secured new deals with Mexico and Canada, South Korea, and is in the final stages of a new deal with the European Union. China is the 800 pound gorilla and we believe Trump will look to make a deal with them once he has signed the pending renegotiated agreements with our other trading partners. In the latest on the trade-policy front, U.S. Treasury Secretary Steven Mnuchin warned Beijing against engaging in a competitive devaluation of the yuan, though he stopped short of accusing China of purposely weakening its currency.
Chinese markets are down YTD and their economy has slowed enough to concern Chinese officials. We believe a deal can be made with China but it will not be easy and we are seeing some of that in the current market volatility.
What were analysts saying?
Sentiment is mixed, spurred by rising interest rates and a general heightened degree of investment difficulty. Bonds matter, trade policy remains a work in progress and the midterm elections are less than one month away. As interest rates trend higher, bonds become a more viable alternative to equities and valuation multiples tend to become compressed.
In the short term, U.S. equity markets are becoming oversold and due for a rebound as the S&P tests first support at its 50-day moving average, the Nasdaq is at its 100-day moving average and the Russell 2000 is at its 200-day moving average at 1,600 support. We believe an oversold rally is likely to develop in the coming few days but volatility will be with us through the midterm elections.
Our take on the immediate cause is that interest rates have played a part. Market's don't like uncertainty, and this change in rates is "new," and therefore introduces and element of uncertainty. When rates spike as they have in the last few weeks, some reaction is unavoidable. Treasury rates are the foundation of valuation in all financial assets, and when they go up it will shake everything. However, it is more common to enter a bear market after an inverted yield curve than during a period of rising rates and strong fundamental economic data. The recent rise in long-term rates has reduced the risk of the US yield curve inverting.
Putting today's sell off in prospective. Our belief is that we are still much better off than we were in February of this year and a long way from any major market blow up. Days like today are when you need to stay focused on your long term financial plan. If you have any additional questions regarding today's sell off or would like to review your financial plan please feel free to reach out to us at your convenience.
